Insider trading cases just got harder to make after a key federal court raised the bar on what prosecutors must prove, in a ruling that also imperils a handful of victories for the Justice Department in its multiyear probe.
Traders must know their tip came from someone who not only knew it was secret, but got something for leaking it, the U.S. Court of Appeals in New York said. In doing so, it threw out convictions of hedge fund managers central to Manhattan U.S. Attorney Preet Bharara’s investigation of illicit trading.
“This ruling looks like a free pass for those trading on inside information,” said Peter Henning, a law professor at Wayne State University and ex-Securities and Exchange attorney. “It’s going to make prosecutors’ jobs more difficult.”
Level Global Investors LP co-founder Anthony Chiasson and ex-Diamondback Capital Management LLC portfolio manager Todd Newman argued their verdicts should be overturned because jurors weren’t told that, to find them guilty, prosecutors must show the additional element that they knew the original source received a benefit.
The decision draws a bright line for what was a murky area of securities law, making it tougher to charge traders the farther away they are from the source of information. While the court is one of a dozen appellate jurisdictions, it includes Wall Street and has purview over Bharara’s convictions, making the ruling a powerful national precedent. Bharara said in a statement he is considering an appeal.
This decision “could stop multiple insider trading cases in their tracks and tarnish” Bharara’s success rate, said Eugene Goldman, a former enforcement lawyer for the SEC. Goldman added that such a high bar for conviction may also be applied to lawsuits brought by the SEC as well.
The unanimous three-judge panel threw the case out “with prejudice,” essentially exonerating the men and barring retrial. In doing so, it undercut the convictions of others swept up in Bharara’s probe, including SAC Capital Advisors LP fund manager Michael Steinberg, whose jury received the same faulty instructions. His appeal has been delayed by the current case.
The “decision clearly means that Michael Steinberg is innocent of any crime and his conviction will be vacated as well,” Steinberg’s lawyer, Barry, Berke, said in a statement.
Steinberg’s conviction was among the biggest victories for Bharara in his prosecution of Wall Street wrongdoing, and at SAC Capital in particular. The probe’s main target, SAC Capital founder Steven A. Cohen, wasn’t charged or sued.
While of little help to traders who got the tip directly from its original source, Henning said the decision may help appeals by so-called “downstream tippees,” who may not have known the identity of the original source, let alone whether they got something in return for the tip.
“This case is not your classic insider trading -- where you have a person tipped about a merger who trades on it,” Henning said. “It gives weight to Raj’s ‘mosaic theory’ and gives weight to protecting a second-level or lower-level tippee.”
Henning was referring to convicted hedge fund manager Raj Rajaratnam, co-founder of Galleon Group LLC. Rajaratnam argued, unsuccessfully, that his trades were innocent because they were based on a “mosaic” of publicly available information obtained from sources as varied as news reports or college buddies.
“The further away you get from the source of the tips, it’s harder to prove how much information did they know,” Henning said.
The government has argued that jurors only need to find a defendant knew a tip was material nonpublic information -- facts that an investor would use to trade -- and that the tipper was violating an obligation to keep it secret.
In defending the convictions, prosecutors argued the information the fund managers received was so detailed and so “overwhelmingly suspicious,” that they should have known it was illicitly obtained.
The court disagreed, saying prosecutors had provided “scant information” Chiasson and Newman had such knowledge in allegedly perpetrating a $72 million insider trading scheme.
“No reasonable jury could have found beyond a reasonable doubt that Newman and Chiasson knew, or deliberately avoided knowing, that such information originated with corporate insiders,” the court said. “In short, the bare facts in support of the government’s theory on the case are consistent with an inference of innocence.”
Bharara, in a statement today, said the ruling “will limit the ability to prosecute people who trade on leaked inside information,” adding that the ruling “appears” to narrow what was considered insider trading.
“We investigated and prosecuted misconduct based on our good faith assessment and understanding of the facts and the law that existed at the time,” he said.
Greg Morvillo, an attorney for Chiasson, hailed the decision, saying it “unequivocally re-establishes” his client’s innocence. Stephen Fishbein, Newman’s lawyer, said he was “relieved but not surprised” by the decision.
“Unfortunately, this vindication comes after four years of unnecessary prosecution,” Fishbein said.
The investigation of the two men led to the shuttering of Diamondback and Level Global.
Steve Bruce, a spokesman for defunct hedge fund firm, Diamondback, at ASC Advisors LLC, declined to comment on the verdict.
“Today’s legal vindication is a reminder how prosecutorial recklessness has real impact on real people,” said David Ganek, a co-founder of Level Global.
During oral arguments, U.S. Circuit Judges Barrington Parker, Peter Hall and Ralph Winter expressed concern that U.S. District Judge Richard Sullivan, the trial judge in the case, made it too easy for the government to obtain convictions in insider trading cases.
All three appellate judges were appointed by Republican presidents Ronald Reagan of George W. Bush.
Sullivan, also a Bush appointee, instructed the jury in Chiasson’s and Newman’s trial that as long as prosecutors proved they knew the tips they traded on weren’t public and breached a fiduciary duty, they could be convicted of insider trading. He didn’t tell the jury that they also must have known the tippers benefited.
Chiasson and Newman pointed to four other federal judges who required that all three elements had to be found by jurors before they could convict.
Chiasson and Newman were convicted in December 2012 of being part of a sprawling insider-trading scheme in which a group of analysts and insiders swapped illicit tips about Dell Inc. and Nvidia Corp, and funneled them to their fund managers.
Berke, Steinberg’s lawyer, last year asked Sullivan to remove himself from that case, arguing prosecutors had improperly steered it to a judge who made it easier to win insider trading convictions.
Other judges required all the elements of the crime. U.S. District Judge Jed Rakoff, in the case of Whitman Capital LLC hedge fund founder Doug Whitman; former U.S. District Judge Richard Holwell, in the case of Rajaratnam and U.S. District Judge Paul Gardephe, in the trial of SAC Capital portfolio manager Mathew Martoma, all required jurors to consider the three elements, rather than the two required by Sullivan.
Despite the extra step, Rajaratnam, Whitman and Martoma were all convicted.
Former Galleon trader Zvi Goffer, who was imprisoned in 2011 for trading on tips leaked by lawyers, asked the appellate court to reopen his appeal so he may advance the same claims as Newman and Chiasson. Goffer, who was tried before Sullivan, lost his appeal last year.
“Identical issue, identical jury instructions and judge,” Goffer’s lawyer, Yale Klat said.
During Chiasson and Newman’s trial, Newman’s analyst Jess Tortora testified that other members of the group swapped inside information on Round Rock, Texas-based Dell and Nvidia. Members included Spyridon “Sam” Adondakis, a former Level Global analyst; Jon Horvath, who worked as an analyst for SAC Capital’s Steinberg; Danny Kuo, who worked as an analyst at Whittier Trust Co., a wealth-management company, and Sandeep “Sandy” Goyal, a Neuberger Berman analyst who once worked at Dell. Steinberg eventually received the information supplied by Horvath, prosecutors said.
All pleaded guilty or were convicted as part of Bharara’s probe.
Goyal described how he obtained nonpublic information ahead of earnings announcements, and passed it to the analysts. He testified that he fed Tortora inside information about Dell from 2007 to 2009 after Tortora paid his wife about $175,000 in consulting fees.
Goyal testified that the illegal tips he obtained were from Rob Ray, a friend who worked in Dell’s investor relations department. Ray was never charged with a crime and his lawyer, Joanna Hendon, said he did nothing wrong.
Hyung Lim, a former Altera Corp. executive who pleaded guilty to passing illegal tips about his company, and Santa Clara, California-based Nvidia, to the group, told Steinberg’s jury he got information about Nvidia from Chris Choi.
Choi was a friend from church who worked in the company’s accounting department, Lim said. He told jurors he passed the information to Kuo in exchange for him agreeing to pay off his gambling debts. Kuo shared the information with the analysts, Lim said.
Choi wasn’t charged by prosecutors.
The appeals court, in its decision today, noted that “although Ray and Choi have yet to be charged administratively, civilly or criminally for insider trading or any other wrongdoing, the government charged that Newman and Chiasson were criminally liable for insider trading because, as sophisticated traders, they must have known that information was disclosed by insiders in breach of a fiduciary duty, and not for any legitimate corporate purpose.”
Chiasson and Newman argued they couldn’t be convicted for trading on information when the sources of those tips hadn’t been charged.
Even the analysts who pleaded guilty and cooperated with the U.S., “knew next to nothing about the insiders,” the court said today. “We reject the government’s position.”
The appeals case is U.S. v. Newman and Chiasson, 13-1917, U.S. Court of Appeals for the Second Circuit (Manhattan).